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Name-Dropping in Offering Materials Leads to Securities Fraud Charges

The Canadian-based principal of a company formed to invest in blockchain companies and digital assets was fined and censured by the SEC for making misrepresentations while soliciting capital. According to the SEC, the respondents used slide decks and other materials that falsely claimed that four prominent blockchain individuals served as advisors to the company. The respondents boasted “access to, and unparalleled relationships with, opinion-makers, the best entrepreneurs, and the highest profile figures in the blockchain community.” The SEC maintains that these false statements helped raise $16 Million in a convertible debenture offering. The Ontario Securities Commission imposed an additional $520,000 fine following a court order whereby the principal agreed to forego his $2 Million interest in the company.

Didn’t know that name-dropping could result in securities fraud? Any misstatement arguably relied upon by investors could give rise to Section 17(a)(2) charges of offering securities by means of an untrue statement of a material fact.

Large Bank Lied about Hedge Fund Due Diligence Process

The SEC fined a large commercial bank for failing to disclose that it only recommended hedge funds that paid a portion of the management fee back to the bank.  The bank marketed a robust due diligence process conducted by a purportedly independent, in-house research group performing a multi-step due diligence process to select hedge funds from an “extremely large universe.”  In fact, the bank only recommended hedge funds that paid back management fees that it called “retrocessions.”  Although the bank disclosed that it might receive revenue sharing and the amount actually received from each hedge fund, the actual due diligence process did not comport with marketing promises.  The bank, which is not a registered adviser or broker-dealer, was charged with violating the Securities Act’s anti-fraud provisions (17(a)(2)).

Check the marketing team’s enthusiasm at the door.  The SEC doesn’t allow firms an exception from the securities laws for product hype, regardless of how clients/investors may perceive the statements.  Rather than caveat emptor (buyer beware), caveat venditor (seller beware) governs sales of securities products.  

SEC Re-Considering Adviser Marketing and Advertising Rules

The SEC’s 2019 regulatory agenda includes amendments to adviser marketing rules.  The SEC will consider Rule 206(4)-1, the general advertising rule that prohibits fraudulent statements and specifically limits testimonials, past specific recommendations, and “black box” claims.  The SEC will also re-visit Rule 206(4)-3, which regulates the payment of cash solicitation fees to third parties.  Last year, the SEC took action on 23 of the 26 rules on its regulatory agenda.

Presumably, this rulemaking review has arisen from last year’s sweep whereby OCIE reported widespread marketing violations including misleading performance claims, cherry-picking results, the use of past specific recommendations, and improper claims of GIPS compliance.  The rules haven’t really changed much in several decades, so a re-boot makes some sense.  We recommend that the SEC consider specific standards rather than relying on a general anti-fraud rule. 

Asset Manager Fined $1.9 Million over Hypothetical Back-Tested Performance

 

 

The SEC fined a large asset manager $1.9 Million for failing to fully disclose that it used hypothetical back-tested performance data in advertisements.  The SEC asserts that the respondent claimed that it could prove back to 1995 that its stock strategy combining fundamental and quantitative research outperformed either approach alone.  Although the firm labeled such research as “hypothetical,” the SEC faults the firm for failing to disclose that its research was based on back-tested quantitative ratings for a time period before it generated its own quantitative models or research.  Using the longer period helped boost the claimed outperformance.  The outperformance data was used in marketing to institutional investors, RFP responses, and a white paper.  The SEC also criticizes the compliance program because compliance personnel that reviewed the materials were not informed that the materials included back-tested data.

OUR TAKE: Do not market hypothetical, backtested performance.  No amount of disclosure can ever insulate you from the SEC’s retrospective criticisms and analysis that you cherry-picked time periods or data.  Also, compli-pros should note that marketing materials delivered solely to institutional investors are subject to the same rules as more widely-distributed marketing materials (with a few exceptions such as allowing presentation of gross performance together with net performance).

SEC Charges Violations of Testimonial Rule

 The SEC settled five enforcement actions against two investment advisers, three investment adviser representatives, and the principal of a third party marketing firm for utilizing the internet to disseminate unlawful client testimonials.  Three of the actions involved a testimonial program sold by the third party marketing firm that solicited client testimonials for publication on social media websites.  Clients lauded the subject firms for service, returns, knowledge, and market access. One of the firms sought positive reviews on Yelp that it would endorse.  One of the firms posted client videos on YouTube.  The SEC charged the principal of the third party marketing firm with causing his client’s violations.  The testimonial rule (206(4)-1(a)(1)) prohibits advertisements that refer to any testimonial about advice, analysis, or services.

OUR TAKE:  Last September, OCIE warned advisers against misleading marketing practices.  It’s hard to believe that advisers could violate the testimonial rule, a clear prohibition that has been in effect for decades.  If you don’t know the rules, hire a compli-pro to ensure you don’t violate the black letter rules.

 

SEC Warns Advisers about Misleading Advertising Practices

The SEC’s Office of Compliance Inspections and Examinations has issued a Risk Alert citing common investment adviser marketing and advertising compliance issues.  OCIE, drawing on over 1000 examinations and its recent “Touting Initiative,” cited several deficiencies: (i) misleading performance results including failure to present performance net of fees, comparisons to inapplicable benchmarks, and hypothetical/back-tested performance, (ii) misleading claims about compliance with voluntary performance standards (i.e. CFA Institute), and (iii) cherry-picked performance and misleading presentations of past specific recommendations.  The SEC also criticized advertising that cited third party awards or rankings without proper explanation.  The SEC urges advisers to “assess the full scope of their advertisements and consider whether those advertisements are consistent with the Advertising Rule, the prohibitions of Section 206, and their fiduciary duties, and review the adequacy and effectiveness of their compliance programs.”

OUR TAKE: OCIE generally issues these types of Risk Alerts in advance of bringing enforcement actions.  Although the SEC has not generally brought enforcement cases solely on the basis of misleading performance claims, this Risk Alert may signal a change in enforcement policy.